46% of taxpayers pay no federal income tax, but that’s not the full story

Even as President Barack Obama pitches the “Buffett rule” to ensure that millionaires pay at least a 30% tax rate, some commentators are decrying the fact that about half of U.S. taxpayers don’t pay any federal income tax.

But our tax system is more complex than any sound bite or simplistic headline can illustrate.

Some multimillionaires do pay a lower effective income-tax rate than some middle-income taxpayers — receiving a chunk of your income via long-term capital gains rather than a paycheck is just one reason that happens. In fact, 1,470 millionaires were among those who paid no federal income tax in 2009, according to IRS data.

But it’s also true that the top 20% of income earners paid 70% of federal taxes in 2007, according to the most recent data available from the Congressional Budget Office. That group also pulled in 60% of total pretax income, according to the CBO.

Meanwhile, 46% of taxpayers won’t owe any federal income tax for 2011, according to the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution.

But those taxpayers will pay a hefty portion of their income to levies at the federal, state and local level. Those include payroll taxes for Social Security and Medicare; state and local sales taxes on groceries, clothing and other purchases; and federal and state excise taxes on things such as gas, cigarettes, alcohol and airline tickets.

Those taxes can hit different income groups in different ways. For instance, the payroll tax for Medicare is paid by all workers, but the Social Security tax isn’t levied on income over $110,100 (in 2012). So people with bigger six-figure salaries pay a lower portion of their income to Social Security taxes than those earning less.

People pay corporate taxes

Meanwhile, wealthy people bear a bigger share of corporate income taxes, which are ultimately borne by individuals.

“All taxes have to be paid by somebody at some point,” said Steve Wamhoff, legislative director at Citizens for Tax Justice, the liberal lobbying arm of the Institute on Taxation and Economic Policy, a research group. “The corporate tax is paid by the owners of corporate stock and business assets.”

In 2011, federal corporate income taxes ate up an estimated 7.7% of income for the top 1% of income earners, compared with a 0.4% bite for taxpayers in the lowest fifth of the income ladder, according to the Tax Policy Center.

But, partly because taxpayers earn money in different ways, the top 1% of earners saw a smaller share of their income go to payroll taxes: 2%, versus a 6.2% hit for the lowest-income group, according to the Tax Policy Center. (Tax-burden estimates assume that employers’ share of payroll taxes is passed on to taxpayers.)

Cash income percentile

Effective payroll-tax rate*

Lowest quintile, below about $16,800

6.2%

Second quintile, about $16,800 to $33,500

8.3%

Middle quintile, $33,500 to $59,500

8.9%

Fourth quintile, $59,500 to $103,460

9%

Top quintile, $103,460 and above

6%

Top 1%, $532,600 and above

2%

*Employer and employee share combined. Source: Tax Policy Center

Then there are state and local taxes to add in. People in the lowest 20% of income earners paid about 17% of their income to federal, state and local taxes in 2011, versus about a 30% effective rate for the top earners, according to an estimate from the Institute on Taxation and Economic Policy. But the share of total taxes paid roughly matches the share of total income for each of the income groups.

“The poorest fifth only pay 2.1% of total taxes,” Wamhoff said. “Well, they only get 3.4% of total income.” The tax system is “a little big progressive, but it’s not outrageously progressive.”

Sales taxes can have an outsize effect on lower-income people. “After they buy basic necessities, they typically won’t have a lot of money left over to save or invest,” Wamhoff said. A wealthier family is “more likely to have a portion of their income that they can put to savings or investments that will never be subject to sales taxes.”

No tax due

What about those 46% who don’t pay federal income tax?

Roberton Williams, a senior fellow at the Tax Policy Center, said 23% of U.S. taxpayers don’t make enough money to owe that tax once they take their personal exemption and standard deduction. Another 23% qualify for tax breaks that bring their bill to zero or provide a refund.

“They start off with relatively low income to begin with,” Williams said, “and therefore have low tax liability before claiming any breaks.”

Wealthier people face a tax rate as high as 35% on earnings, “but they get the biggest tax breaks,” he said. “They start off with such a high tax that the biggest tax breaks don’t bring them down to zero. They’re benefiting hugely from tax breaks — much more than the poor people — but because they start off at the high level, their tax bills stay positive.”

For instance, Williams said, about 95% of the benefit of the current 15% tax rate on long-term capital gains and qualified dividends goes to the top 20% of income earners.

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